Education / Forex market/ Traded instruments

There is both an over-the-counter (OTC) market in foreign exchange and an exchange traded segment of the market. The OTC market is a network of major dealers - mainly but not exclusively banks - operating in financial centers around the world, trading with each other and with customers, via internet, telephones and other means. The exchange traded market covers trade in a limited number of foreign exchange products on the floors of organized exchanges located in Chicago, Philadelphia, New York and other cities.

The foreign exchange products traded in the OTC market include three "traditional" instruments - spot, outright forwards and Forex swap, which were the only instrument traded before 1970s, and which still constitute the overwhelming share of all foreign exchange market activity. It also covers two more recent products in which OTC trading has developed since 1970s - currency swaps and OTC currency options.

Spot transaction is a foreign exchange transaction in which each party promises to pay a certain amount of currency at an agreed exchange rate to the other on the same day or within one or two days. A company using the spot market to deal in foreign currency is using the simplest method available. However, it also carries the most risk as it does not allow the company to protect against adverse movements in exchange rates between pricing a contract and the need to buy/sell the foreign currency.

Outright forward is an agreement to exchange fixed quantities of two currencies at a specific future date. It, like a spot transaction, is a straightforward single purchase/sale of one currency for another. The only difference is that outright forward is settled on any pre-agreed date three or more business days after the deal date. Dealer use this term to make clear it is a single purchase or sale on a future date, and not pert of a FX Swap. The outright forward is a common transaction between a currency dealer and a non-bank customer, but relatively less common in the inter bank FX market.

Forward FX swap means a purchase of one currency against another at an initial date and an agreement to reverse that transaction at a future date and at a specified rate. The difference between the exchange rate applying initially and the rate at which the swap is reversed reflects the interest differentials between the two currencies concerned (the forward points). Initially used to extend or match cash flows with the physical delivery of imports or exports, FX swaps have come to be used also as a funding mechanism against short-term borrowings or by the professional market to speculate on interest-rate movements.

OTC foreign currency option
A foreign exchange option contract gives a buyer the right, bur not the obligation, to buy or sell a specific amount of one currency for another at a specified date. Options are unique in that the right to execute will be exercised only if it is in holder's interest to do so.